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S&P Upgrades Delta Air Lines (DAL) to 'BB+'; Sees Credit Measures Continuing to Strengthen

July 23, 2015 12:40 PM EDT

Highlights:

  • Delta Air Lines Inc. is reporting solid earnings and free cash flow, both of which should continue to improve now that the company has settled most of its fuel hedges.
  • We expect that Delta's credit measures will improve despite the increased share repurchase program the company announced in May 2015.
  • We are raising our ratings on Delta Air Lines Inc., including our corporate credit rating, to 'BB+' from 'BB'. The outlook is stable.
  • The stable outlook incorporates our expectation that Delta's credit measures will improve in 2015, but that further gains will be more gradual thereafter.

Standard & Poor's Ratings Services said today that it has raised its ratings on Delta Air Lines Inc. (NYSE: DAL), including our corporate credit rating on the company, to 'BB+' from 'BB'. The outlook is stable.

At the same time, we raised many of our issue-level ratings on the company's debt, but affirmed certain pass-through certificates whose particular circumstances did not support an upgrade under our criteria. In particular, we did not raise our ratings on certain Class A certificates because the rating on the related liquidity facility provider, which caps the certificate rating under our counterparty criteria, was already at the same level as the existing ratings on the certificates. We did not revise any recovery ratings.

"The upgrade is based on our expectation that Delta's credit measures will continue to strengthen in 2015 and 2016," said Standard & Poor's credit analyst Philip Baggaley. Delta reported second-quarter 2015 adjusted pretax income of $1.64 billion, compared with $1.44 billion for the same period a year earlier. This is after deducting $720 million of mark-to-market fuel hedge losses that the company reported under generally accepted accounting principles (GAAP) in 2014, but which were settled in second-quarter 2015. Without those (and other minor) adjustments, Delta's GAAP pretax income was an impressive $2.37 billion (compared with $1.44 billion in 2014). Passenger revenue per available seat mile (PRASM; an airline industry measure of revenue generation) declined by 5%, but the company's fuel expense was much lower (even including hedge losses) and its nonfuel cost per available seat mile (CASM) declined by 1%. The pressure on Delta's revenue generation is similar to the trends at other airlines and reflects a combination of translating revenues from foreign-currency ticket sales at a lower rate against the strong dollar and some increased domestic and overseas pricing competition. In response, Delta and some other U.S. airlines are scaling-back the number of flights they will have on selected international routes in the fourth quarter relative to their previous plans.

The stable outlook reflects our expectation that Delta's credit ratios will improve in 2015, but that further gains will be more gradual because of increased share repurchases. We are also mindful that 2015 and 2016 will likely be peak years for the U.S. airline industry, and changes in either the relatively favorable economic conditions or low fuel prices could pressure the company's earnings at some point in the future.

We believe that a downgrade is unlikely; however, we could lower our ratings on Delta if the company's earnings and cash flow weaken because of softer demand or an increase in fuel prices such that its funds flow-to-debt ratio remained below 30% with little prospect of improvement. Such an outcome could occur also if Delta adopted a more aggressive financial policy involving debt-funded share repurchases.

While unlikely, we could raise our ratings on Delta if the company's credit measures improve more rapidly than we expect, with a funds flow-to-debt ratio consistently in excess of 45% and a free cash flow-to-debt ratio of more than 25%. This could occur because of a combination of stronger-than-expected earnings, debt paydowns, and a material shrinkage of the airline's retiree liabilities due to higher interest rates, excess funding of employee pensions, and strong pension fund asset performance. In such a scenario, we would also focus on the sustainability of such gains, given the industry outlook at that time.



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